Govt disallows $1.24 bn RIL cost recovery

The Petroleum Ministry disallowed the RIL’s (Reliance Industries Ltd) $1.24 billion cost recovery from its investment in the KG-D6 field, in the Krishna-Godavari (KG) basin.

RIL has already taken the government to the Supreme Court over its inability to nominate an arbitrator over the issue of cost-recovery.

Why Govt’s Notice to RIL?

A Notice was sent by the Petroleum Ministry to RIL, disallowing RIL a cost recovery of $457 million for 2010-11 and $778 million for 2011-12 due to RIL’s inability to meet drilling commitments. Thus, the Oil Ministry has disallowed RIL a total cost recovery of $1,235 million (=$457+778) or nearly $1.24 billion.

The Oil Ministry is planning not to allow RIL this cost recovery from the D6-block for 2010-11 and 2011-12. Alternatively, the Ministry wishes the sum to be added to ‘Profit Petroleum’ for the respective years.

What this could mean for the Govt?

The disallowed cost recovery would imply the government’s profit petroleum for FY11 and FY12 would increase by that amount.

What is ‘Profit Petroleum’?

Under the NELP (New Exploration and Licensing Policy), the government at first allows companies to recuperate their cost from revenue. The companies afterward share a percentage of the production with the government, termed as ‘Profit Petroleum’. Both the ‘drilling’ programme and the share in ‘Profit Petroleum’ are biddable components for the oil and gas blocks. Thus, ‘Profit Petroleum’ is the government’s share from hydrocarbon blocks i.e. govt’s share of profit from an oilfield. Government can decide to take either royalties or petroleum in kind.

Another definition (as per the Directorate General of Hydrocarbons):

‘Profit Petroleum is the total value of Petroleum Produced and Saved from the Contract Area in a particular period, as reduced by Cost Petroleum and calculated as provided in the Model Production Sharing Contract (MPSC).’

What is the whole issue about and what does the Petroleum Ministry contends?

First, Background:

On April 12, 2000, RIL and the Government went into a Production-Sharing Contract (PSC) to develop the KG-D6 basin. Under PSC, the operator of a gas reservoir is permitted to subtract the cost obtained in developing the asset from the revenue earned by selling the gas, and pay the government a share of profit from the balance.

The gas production from the KG-D6 field over the last few quarters has increasingly decreased and is under the level it should have attained by now.

CAG Hits at both RIL and Govt: In June 2011, a CAG Report was leaked in Media, which criticized both Reliance and the government over progress of the KG gas field.

The CAG’s report conveyed doubts about RIL’s proposed $8.5-billion development cost for KG-D6 block, and held that in future the operator could further elevate capital expenditure as RIL had at first quoted $2.4 billion as the initial development cost for producing gas from its D1 and D3 fields in KG-D6. Thus, the CAG audited the accounts of Reliance’s D-6 block and oppugned its move to raise capital expenditure.

The CAG report also alleged that the Oil Ministry had twisted the rules to suit RIL.

Thus, Oil Ministry felt duty-bound to issue the strict notice to RIL in order to shield itself from unpleasant remarks of the CAG.

Following this, the legal opinion given to the government held that RIL seemed to have front-loaded the retrievable cost, which was disproportional to the present level of gas production, and that ideally the cost recovery should be restricted to corresponding present o/p levels. Such front-loading of the costs by RIL implies that the revenue to be shared with the government drops correspondingly. As of March 31, 2011, RIL had invested $5.69 billion in the block and had so far recovered $5.26 billion. Now, based on the legal opinion, the government had been considering restricting the costs RIL can claim for developing the field.

Thus, the dispute refers to the retrieval of costs for developing KG-D6, where gas production has decreased since last year and the KG-D6 block is at the middle of this controversy that broke out after the CAG held in its report that RIL had violated some conditions of its contract with the government.

Now, the Petroleum Ministry contends that:

RIL has breached its committed work programme in the Production Sharing Contract (PSC).

RIL was unable to fulfill “obligations” under the PSC and “intentionally and wilfully caused violations, which eventually resulted in huge loss and prejudice to the government and the people of India”.

Lower than expected production by RIL from the oil-fields has led to under-utilization of the oil-field facilities.

Together with 6.5 mscmd of output from the MA oilfield in the same block, the KG-D6 output is around 34 mscmd as against the nearly 70-mscmd target (61.88 mscmd from D1 & D3 and eight mscmd from the MA field).

Fall in O/P from 53-54 mmscmd achieved in March 2010

Drilling of less than the committed wells

RIL should have by April 2012, put 22 wells on production and 31 wells by the end of the 2012. But, RIL has so far drilled 22 wells on the fields but has put on production only 18 wells. The other 4 wells have not yet been connected to the production system.

Of the 18 wells, 6 had to be shut because of high water and sand ingress and a fall in pressure. RIL believed the field had not behaved as predicted and so indiscriminate drilling would be a big drain on cost.

The dispute b/w the government and RIL over gas production shortfalls from RIL’s KG Basin wells has hit an impasse.

Timeline:

April 12, 2000: RIL and the Government went into a Production-Sharing Contract (PSC) to develop the KG-D6 basin

June 2011: CAG Report leaked in Media, which criticized both Reliance and the government over progress of the KG gas field.

October 2011: RIL looked for an elucidation from the oil ministry over reports that the government wouldn’t permit a big chunk of retrievable production costs due to RIL’s inability to conform to production commitments. November 2011: RIL wrote to the government inviting arbitration on the matter, but actually did not get a response.

April 17, 2012: RIL and a subsidiary of its Canadian joint venture partner, Niko Resources Ltd, petitioned the Supreme Court asking that the government be directed to nominate an arbitrator.

May 3, 2012: Government wrote to RIL asking it to refund $1.25 billion in production costs, which the company accounted for as per its reading of the production-sharing contract over the last two years.

Technically arbitration can only begin once RIL objects to the Govt’s notice.

But, the Government now appears to bow down a little and enter arbitration proceedings with RIL, its British partner BP Plc, Hardy Oil and Gas Plc and a subsidiary of Canadian joint venture partner Niko Resources Ltd over the issue.